Assessing the Economic Recovery

The University of Massachusetts Boston John W. McCormack Graduate School of Policy and Global Studies Boston, MA

In a speech today at UMass Boston, Boston Fed President Eric Rosengren illustrated how unusually weak this recovery has been, which emphasizes the need for continued accommodative monetary policy.

Since January, the unemployment rate has declined from 7.9 to 7.2 percent, and interest-sensitive sectors such as housing and autos have continued to improve. But despite these gains, the economy remains challenged. "Unemployment is well above what anyone would consider a 'full employment' rate, and inflation remains well below our 2 percent target," said Rosengren.

The Fed's monetary policymaking has helped keep interest rates low, encouraging recovery in sectors of the economy that are interest-sensitive. However, monetary policy has not been able to fully offset the headwinds created by the financial crisis, fiscal retrenchment, and unusually weak economies among many trading partners.

Rosengren pointed out that in the three most recent recoveries, employment returned to its previous peak within two years. But "despite the significant lapse of time since the trough of the recession in 2009, we still have not reached the pre-recession peak in employment," he said. "The severity of the employment loss, and the significant headwinds facing the economy after the severe financial crisis, are both important reasons why monetary policy has needed to remain quite accommodative."

One of the unusual features of this recovery has been significant fiscal retrenchment. The Congressional Budget Office (CBO) estimates that fiscal austerity measures like higher income taxes and substantial reductions in real government spending have reduced 2013 GDP growth by 1.5 percentage points - a very significant headwind.

"Had the economy grown by 3.5 percent rather than 2 percent over the past year, job growth would almost surely have been stronger, unemployment lower, and inflation closer to the two percent goal," said Rosengren.

Rosengren presented analysis suggesting that a growth rate below 3 percent will result in a long wait to reach full employment - exacting, of course, a heavy human toll. "At a growth rate of 2.8 percent, we do not attain 5.25 percent unemployment until the end of 2018."

"Even when the Fed eventually removes some of its accommodation, such as large-scale asset purchases, we will in my view need to leave short-term interest rates at their very low levels until there is much more progress reaching full employment and the 2 percent inflation target," he added.

The pace at which the Fed raises rates, when that becomes appropriate, should be in Rosengren's view quite gradual - unless the economy picks up much faster than is currently expected.

Overall, Rosengren believes that monetary policy needs to continue to be data driven and, of course, to be focused on meeting the Fed's dual mandate – within an appropriate time frame.